MONEY COMMENT
The Five Worst Things About Pensions

By Cliff D'Arcy
November 12, 2004

Earlier this week, I wrote an article in praise of pensions, Five Reasons To Get A Pension.

Although I'm a delighted member of The Motley Fool's company pension scheme, I recognise that pensions aren't everyone's pet products! Here are five reasons to tread carefully when saving for retirement:

1. Widespread mis-selling of personal pensions

Personal pensions were introduced in 1988. In order to maximise sales, pension firms offered sky-high commissions to financial advisers who sold their products. Predictably, this temptation to earn megabucks proved too great, and many advisers – even entire firms – abandoned 'best advice' and pushed personal pensions to all comers.

As a result, millions of people are stuck with poor-performing and unsuitable pensions – and pension companies face a multi-billion-pound compensation bill. Although tougher regulation has forced firms to clean up their act, years of non-stop mis-selling has left personal pensions with an awful reputation.

If you have a personal pension sold to you before low-cost Stakeholder pensions were introduced in 2001, you should build a bigger pot by transferring it to a cheaper fund, despite exit penalties. Learn more in Don't Get Caught In The Pensions Trap (I wrote this article in May 2003; the free 'pension transfer analysis' is no longer available).

2. Ridiculously high charges

Of course, in order to pay massive commissions to their sales staff, pension firms had to recoup the money from somewhere. And, unsurprisingly, customers coughed up, through eye-wateringly high charges on personal pensions. In many cases, these charges were so staggeringly high that they swallowed up all of the first ten (or even fifteen) years' returns! Imagine paying in £200 a month for ten years, only to find that your pot is worth less than the £24,000 that you'd paid in!

Thankfully, the introduction of Stakeholder pensions in April 2001 has led to the death of almost all high-charging personal pensions. Stakeholder pensions don't charge initial or transfer fees and their annual management charge is capped at 1%, with some plans charging 0.4% a year or less.

3. For some people, pensions are a waste of time

In certain cases, pensions simply aren't worth having. For example, they are beyond the reach of many low-income or part-time workers, for whom pensions are unaffordable and unattractive. After all, why save money for years, only to find that the extra retirement income generated is cancelled out by the loss of means-tested State benefits!

The government currently guarantees to provide a minimum income to pensioners, by topping up the basic State pension with the much-criticised Pension Credit. How long it will continue to do so remains to be seen, given the rising cost of supporting the UK's eleven million pensioners. But, for now, it doesn't make sense to save into a pension if you believe that you'll be a low earner for most of your working life. You'll have to put your faith in the government instead – what a scary thought!

4. Annuities offer poor value for money

So, you build up a pension pot by saving throughout your working life, but how do you turn it into a reliable income? The usual route is to buy an annuity from an insurance company. This is a guaranteed income that will be paid to you from when you hand over your pot until the day you die.

However, there's a huge catch: when you die, your pot dies with you. So, if you hand over £100,000 for an income of, say, £6,000 a year and then die after just one year, you've lost out big time, giving the insurance company a winning gamble on your life expectancy!

What's more, annuity rates are linked to long-term interest rates, which are currently at historically low levels. What this means is that your pot currently buys you around half the income that an identical sum would have purchased, say, fifteen years ago.

I really dislike being forced by law to buy an annuity by the time I reach 75. Given that day is almost forty years away, I know that between now and then, the government will allow pensioners with large pension pots to manage their own funds in order to generate income (see the A-Day comments below). In other words, I aim to avoid buying an annuity and, instead, plan to invest the funds myself in order to fund a comfortable – and secure – retirement. This option isn't for the faint-hearted or foolhardy!

5. Pensions are so incredibly complicated

Although I know more about pensions than your average worker, I'm no expert (but several of the contributors to our Pensions discussion board are). However, it strikes me that the whole system is a hideously complicated mess. It has its own baffling jargon, from AVCs to WoP (Additional Voluntary Contributions; Waiver of Premium).

However, things should improve from April 2006, when A-Day for pensions arrives. This sweeps away or simplifies many of the rules governing the various types of pensions, which should make pensions somewhat easier to follow!

Finally, I still have faith in pensions. For example, every year I persuade my wife to invest a big chunk of her annual bonus into her ultra-low-cost company pension scheme. Of course, I wouldn't encourage Mrs D to contribute the maximum (15% extra) into her pension every year if there was the slightest chance that she'd come a cropper. Trust me, it'd be more than my life's worth!

More: Visit our Pensions centre | How You Can Solve The Pension Crisis.